5-Minute Huddle: A Note

March 16, 2020

By Justin Pawl, CFA, CAIA

In this week’s edition:

  • Financial markets, central banks, and governments’ responses to COVID-19 are changing rapidly.
  • Reminders for how to protect yourself and your portfolio.

Last week saw the longest-running U.S. equity bull market end shortly after entering its 12th year. The daily volatility of the market accompanying the end of the bull market is remarkable, but not unprecedented. However, the fact that markets have been here before is cold comfort to anyone watching the daily stock market price fluctuations, and we are empathetic to the emotional roller coaster this market is inducing. Our Investment Committee held several interim meetings last week to ensure portfolios are behaving as expected and to plan portfolio changes in light of shifting expectations for the economic environment ahead.

Friday’s rally was a relief following a week of daily losses, and the largest daily decline since “Black Monday” when stock prices collapsed on Monday, October 19, 1987. However, it is too early to believe that the “all clear” sign is flashing for equity markets to begin a new bull market. The economic damage realized thus far, and that will continue to reverberate through the economy as social-distancing becomes the norm has yet to show up in corporate earnings and economic data. In all likelihood, we will see negative GDP growth in the second quarter as the efforts necessary to contain the virus and preserve human lives, hamper business activity, and lead to a higher unemployment rate.

It’s also worth noting that the emotional and tangible impacts of this virus will not pass quickly. Unfortunately, this is not a one-quarter phenomenon. We can, and should, expect the virus to be a constant source of news into the summer, and perhaps beyond. All the while, financial markets will be reacting to changing economic data, fiscal and monetary policy responses, and corporate earnings. Suffice to say, the effects of this virus will be far more severe than anyone realized when it first made news in early January. As we’ve witnessed over the last several weeks, the market reaction has been swift. Indeed, the decline in global stock prices is as severe as the first 150 days of the Global Financial Crisis, though it occurred in about one-third of the amount of time.

One can argue that the popularity of passive investing likely accelerated this sell-off, but that’s not the point. The point is that investors have largely priced in a disaster. Hence, any positive developments with regards to curtailing the virus or the potential economic damage could spark a sustainable rally. We don’t believe we are there yet, and further equity market declines in the next several months are probable. Nevertheless, this is not the type of virus that threatens the existence of the human race, and we will recover from this natural disaster, just as we’ve recovered from previous natural and human-made disasters.

Over the weekend, the House of Representatives passed a bipartisan bill to provide funding for free COVID-19 testing and paid sick leave. This is the first salvo of fiscal stimulus, and we expect more will be on the way. The Federal Reserve also took steps to ensure financial markets operate normally, reducing the target rate range to approximately 0% and formally committed to $700 billion of Quantitative Easing (i.e., the purchase of $500 billion of U.S. Treasuries and $200 billion of mortgages). These actions will not eliminate the impact of COVID-19, but they should help to blunt some of the potentially more extreme outcomes.

So, what to do in the meantime? Follow your investment plan and try to avoid watching the tick-by-tick moves of the financial markets. Most market moves contain more noise than signal, and it’s very easy to fool yourself into thinking a trend is evolving. For example, if you had sold out of your positions on Thursday when the market made a momentous move down, you would have missed Friday’s rally, which was the 10th largest daily market gain since 1926.  Most importantly, take care of yourself and your loved ones.  There is a great deal of misinformation regarding how to combat COVID-19 making its way around social media sites.  Rather than rely on social media, please visit the CDC website for help with dealing with this outbreak.  In short, combatting COVID-19 is fairly straightforward:

  • Wash your hands often with soap and water for at least 20 seconds, especially after blowing your nose, coughing, or sneezing; going to the bathroom; and before eating or preparing food.
  • Avoid touching your eyes, nose, and mouth with unwashed hands.
  • Stay home when you are sick.
  • Cover your cough or sneeze with a tissue, then throw the tissue in the trash.

What is Covenant doing? We are rebalancing client portfolios, harvesting losses to offset future gains where possible, and changing portfolio holdings to reflect our evolving view of the global economy. Fortunately, we made many of these changes before the beginning of this year, but portfolios can always be improved following large dislocations.

From an operational standpoint, Covenant is taking precautionary steps in line with the national effort to slow the spread of the virus. Specifically, Covenant has: eliminated onsite non-client meetings at all of our office locations, halted non-essential travel, limited internal meetings to a few people (using video conferencing for larger meetings), and we’ve required employees who have traveled on an airline to self-quarantine at home for 14 days. All of these actions are designed to ensure our clients continue to receive the same level of high-quality service they’ve always enjoyed. Covenant remains open for business and stands ready to help you and your loved ones through this event and beyond.

With gratitude, love, and faith,

Justin